As companies have continued to consolidate during the oil and gas market downturn, Céline Delacroix, Associate Partner, EMEIA Oilfield Services at EY, explains how this activity is creating investment and growth opportunities in the oilfield services sector.

The downturn has plagued the oil and gas sector over the past few years, but marked signs of recovery are now apparent, with improved oil prices, demand on the up and international oil companies reporting an increase in earnings – at the end of 2017, returns on capital of international oil companies reached their highest level since 2014.

As market conditions improve, operators are moving from focusing on survival to generating returns, diverting more capital to cost-advantaged basins and plays, or those that show a greater amount of capital flexibility. So, given this recovery, why is the oilfield services (OFS) sector lagging behind?

Celine Delacroix

Early stages of recovery

Notably, the current oil market cycle has differed from the norm. Cycles typically follow a regular pattern: high prices encourage investment in resources; operators and service companies boost assets and manpower; production outgrows demand, prices fall, profits crash and investment dries up; production falls flat, demand continues to grow, prices recover and it begins again.

This time, the shale revolution has resulted in improved rig productivity, meaning production, particularly in North America, has grown despite the fall in capital investment. Prices have only recovered due to OPEC’s continuing production restrictions.

As a result, OFS companies have continued to experience the most arduous effects of the downturn. The supply chain in higher-cost basins and more asset-intensive areas, in particular, has suffered, due to unreliable demand and price competition. In response, companies have cut operating costs, moved capacity out of the market and cut prices. During the early stages of a downturn, companies will typically have contracts in place to sustain them for a period of time. If these expire before the market recovers, it becomes a matter of survival – a stage that many are still at now.

Eventually, however, these productivity gains will run their course and demand for oil will result in more capital being injected into wells. When activity picks up, service revenue intensity will increase – greater tendering activity, new contracts for idle rigs and vessels, and increasing utilisation are already apparent.

We are seeing an uptick in the cycle and, eventually, pricing will increase and the market will return to medium- to long-term contracts; however, for some contractors, it will likely be several quarters, if not years, before this happens. In the interim, it will be down to OFS companies to manage their capital well, and undertake fixed, lower-rate contracts with caution.

Opportunities for investment

While the current environment remains tough, the OFS sector’s positioning in the cycle means opportunities for future growth are rife. Consolidation, portfolio optimisation and merger and acquisition (M&A) activity have increased. In 2017, we saw 215 deals announced globally in the OFS sector, a 13% rise compared with 2016 levels.

This has been driven by several key factors. A focus on cost efficiencies has resulted in more value chain integration, as companies enter into partnerships, joint ventures or full consolidation; the need to achieve economies of scale has driven the creation of dominant companies with broader asset portfolios; and the push to reduce commoditisation and enhance offerings has led to continued technology and digital data integration. Financial stress, too, has been a key driver, as companies are forced to liquidate or sell assets.

These factors will create further investment and growth opportunities, alongside increased access to capital markets. We saw a surge in global initial public offering (IPO) activity in 2017, with the OFS sector raising approximately US$2 billion, out of Canada, the UK and the US. On the debt and equity side, capital market conditions have continued to be robust. While banks remain cautious, there is appetite to provide debt to new customers, and financing opportunities are available in both the bond market and from alternative financial investors, such as hedge funds, depending on individual requirements.

The OFS market has started to recover. With M&A activity expected to strengthen in 2018, supported by an expected upsurge in upstream capex spending and an improving oil price environment, there are clear opportunities to seize, by financial investors and industry players alike, which will not be available for long.